August 19, 2009

SEC Provides Guidance on FASB Codification

As Broc previously noted in the blog, the FASB Codification project was launched back in July and will be effective for financial statements issued for interim and annual periods ending after September 15, 2009. Under the FASB Codification, existing references to U.S. GAAP materials are replaced by new references, thereby rendering all existing references obsolete.

Yesterday, the SEC issued an interpretive release in order to address the issues for SEC materials that are raised by the Codification. In the release, the SEC indicates that all references to the “legacy” FASB standards (and other private-sector US GAAP literature) in rules, regulations, releases and staff bulletins should be construed as the corresponding reference in the FASB Codification. The SEC notes that it will be embarking on a longer term project to revise U.S. GAAP references in its rules and guidance.

The SEC also asserts its GAAP supremacy in the release, noting that while the FASB Codification supersedes existing U.S. GAAP references from private standards-setters, it does not supersede any SEC rules or regulations. In this regard, the SEC notes that the FASB Codification is not the authoritative source for SEC rules and regulations, which are referenced in the Codification for the convenience of users.

Corp Fin Provides MD&A Guidance on Loan Losses

A new “Dear CFO” letter provides some guidance to financial institutions on what the Staff expects in terms of MD&A disclosure around an institution’s provision and allowance for loan losses. While the disclosure requirements have not changed, the Staff indicates that the current economic environment may require that a company “reassess whether the information upon which you base your accounting decisions remains accurate, reconfirm or reevaluate your accounting for these items, and reevaluate your Management’s Discussion & Analysis disclosure.”

The letter lays out the Staff’s disclosure expectations around high risk loans (e.g., option ARM products, junior lien mortgages, subprime loans), changes in practices for determining the allowance for loan losses, declines in collateral value and other potentially material considerations, such as risk mitigation strategies, the reasons behind changes in key ratios (such as the non-performing loan ratio), and how accounting for an acquisition under FAS 141R or accounting for loans under SOP 03-3 affects trends in the allowance for loan losses.

Benchmarking in the Spotlight

An article in yesterday’s WSJ discussed two new academic studies that have focused on benchmarking practices at public companies. While the article tends to sensationalize the issue a bit, it does note how the studies highlight one of the principal failings of benchmarking, which is the way in which peer groups are selected. In particular, the studies appear to demonstrate a bias toward selection of peer companies with better paid CEOs, compounded by a trend noted in one of the studies that approximately 40% of the companies reviewed indicated that they paid their CEOs more than the median level of comparable pay. In the article, the typical competitiveness arguments are noted in support of benchmarking. The article observes that these studies were made possible by the 2006 amendments to the executive compensation disclosure rules, which require disclosure of the list of peer companies when benchmarking is used.

Obviously this is not any breaking news; rather, what is noteworthy is that there is now some empirical support (which, of course, should always be taken for what it is worth and in consideration of its limitations) for some of the claims about benchmarking. It certainly helps to confirm what then-Corp Fin Director Alan Beller so eloquently said at our conference back in 2004:

“Too many boards have apparently operated on the principle that compensation must be in the top half or even the top quartile of some benchmark group (the basis of selection of which is often not disclosed) for the company to be competitive in attracting executive talent. (This principle apparently operates without regard to whether performance is commensurate to compensation). This approach produces what I have called the Lake Wobegon effect, where everyone is above average. Boards of directors ought to be able to do better than this.”

What can be done now, in light of this new evidence of the obvious? I think that one place to start is the useful guidance provided in the Obama Administration’s broad compensation principles announced in June, which call for developing an improved pay for performance paradigm that is less focused on external competitive positioning and more focused on relative performance of the company, achieved through a diversified set of performance criteria having an emphasis on long-term value creation.

For more analysis of the Administration’s compensation principles, be sure to check out this complimentary copy of the Summer 2009 issue of Compensation Standards. Also note that you can sign up to be a member of for free for the rest of this year when you try a 2010 no-risk trial.

– Dave Lynn